Understanding Investment Income

When it comes to your taxes, not all investment income is treated equally.

A popular regular feature in Good Times magazine is “Your Questions,” where Olev Edur provides answers to questions from our readers regarding their rights, personal finance, and estate planning. Here’s one on the three different kinds of investment income:

Q.I’m nearing retirement, so I’ve been investing in GICs, in addition to putting some money in mutual funds and in the stocks of two companies that have done very badly ever since I bought them. I recently tried to claim the losses from these stocks on my income tax return, but I was told by someone at Canada Revenue Agency (CRA) that I couldn’t claim an investment loss unless I also had a gain.

I explained that my GICs were investments, too, and that I should therefore have been able to use the losses from those shares to offset my gains from my other investments, but CRA said that this wasn’t possible. So where does CRA draw the line between an investment and whatever a GIC is considered? How can you have both losses and gains from the same investment? I’m hoping you can help me understand—even if the answer doesnt work in my favour.

A. What CRA is talking about is the different types of earnings that are derived from different investments, rather than the investments themselves. For tax purposes, there are three basic types of earnings that you can derive from different investments:

Interest income. This is what you earn from GICs, bonds, term deposits, and the like. This income is taxed in the same way as employment income and pension benefits; the entire amount must be added to your income and taxed at whatever marginal tax rate applies.

Dividend income. This income represents money that corporations periodically pay to shareholders out of their after-tax profits. From a tax perspective, there are actually three categories of dividends. Generally, “eligible” dividends from Canadian-controlled, publicly traded corporations are accorded a substantial tax credit in recognition of the fact that this income has already been taxed once at the corporate level. “Non-eligible” dividends are from smaller private corporations that pay lower tax rates, so the dividend tax credit (DTC) is set at a lower rate. Finally, dividends from foreign-controlled corporations are accorded no credit and treated as fully taxable income, the same as interest income.As a result of the way the DTC works, the amount of tax you end up paying on eligible dividends can range from zero (if you have little or no other income) to an amount equal to about two-thirds of the rate on interest income; on non-eligible dividends, the top tax rate amounts to about 80 per cent of the top rate on interest income. These rates are very general approximations, though, because each province and territory also applies its own credit rates to dividends, and these can differ considerably.

Capital gains. These earnings aren’t considered income, and this is where your confusion arises. Capital gains represent profits stemming from the sale of stocks, mutual funds, real estate, and other capital assets (including bonds that are sold on the secondary market rather than being held until maturity). As you have found, such assets can go down as well as up in value, generating capital losses instead of gains. Because of the risk of losses as well as gains, and because of the economic importance of encouraging such investments, the tax rules allow you to exclude half of any gains from income; conversely, only half of any losses can be claimed as a deduction, and they can be claimed only against capital gains from other investments.You can, however, carry capital losses forward and use them to offset gains you may earn in future. Accordingly, you should include them on your tax return even though you may get no tax reduction at the time. The government will then let you know each year on your Notice of Assessment how much you have accumulated in terms of capital loss carry-forward amounts.